Bob Diamond in the red

August 3, 2009

Just how profitable is Barclays Capital?

At first glance, the answer would be: very.  According to Barclays’ results, Bob Diamond’s investment banking empire made a £1bn profit in the first six months of the year, double last year’s figure. That’s despite continuing hefty write-downs on toxic assets.

Indeed, as other parts of Barclays succumb to the economic downturn, Barcap, buoyed by last autumn’s acquisition of the North American operations of Lehman Brothers, more or less appears to be keeping the bank afloat.

So it was with some surprise that, ploughing through Barclays’ 124-page announcement, I came across the following on page 75:

Barclays Capital economic profit increased 11% (£12m) to a loss of £94m (2008: loss of £106m), due to a 100% increase in profit before tax driven by a very strong performance in the underlying business offset by a 104% increase in the economic capital charge reflecting an increase in economic capital allocation due to market volatility, an increase in the economic allocation for monoline exposures and further downgrades across credit markets, securitisations and loan exposures.

A little background: economic profit is an internal measure used by Barclays’ top brass to calculate the profitability of its divisions while taking into account the capital they consume. It is used when considering future investments and -crucially – when calculating bonuses.

What has happened is that Barclays has doubled its internal capital allocation for Barcap. As a result, the investment bank did not earn its cost of capital in the first six months of the year.

True, these metrics can produce some odd results. Barcap also reported an economic loss in the first half of 2008. But in the second half – the worst six months for investment banking in living memory - Barcap reported an economic profit of £931m.

Even so, it’s striking that Barcap will in future have to carry a bigger share of its parent bank’s enlarged capital base. Whether Bob Diamond and his team can generate a return on that capital remains to be seen.

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